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Building a Bridge Over the Coming Pension Cliff

Article written in CSMFO Magazine providing guidelines about pension funding policies.

How to Build a Fiscal Bridge Over The Coming Pension Cliff November 20th, 2019|Featured Articles

The Essential Pension Policies Elements to Adopt Now By Julio F. Morales, Director, UFI Tackling the growing pension and OPEB liabilities of state and local public agencies will likely be the most significant challenge many government finance officers face during their career.

After nine years of strong revenue growth and consecutive positive investment performance, a substantial pension funding gap remains for most public agencies. The funded status for the entire CalPERS’ Public Employees Retirement Fund (PERF) is approximately 70%, after an investment return of 6.70% and 8.60% for the fiscal years ending June 30, 2019 and June 30, 2018 respectively.

Pension and OPEB liabilities are dynamic. A public agency’s funding level depends on a number of variables, including contribution amounts, benefit levels, investment performance, inflation, actuarial assumptions and plan adjustments.

In accordance with GFOA’s recommendations, every public agency should consider retaining an independent financial advisor that specializes in pension/OPEB issues. This specialist will be able to help the public agency understand the financial impact of its long-term liabilities, develop a custom pension/OPEB model, conduct financial projections, evaluate options, and make recommendations.

Addressing pension/OPEB liabilities requires long-term, sustained financial discipline by a public agency. After studying the issue, evaluating the options, and developing a plan of attack, every public agency should adopt appropriate pension/OPEB funding policies to reinforce the required discipline and keep the agency on-track. The Importance of Pension/OPEB Funding Policies

  • Pension and OPEB funding policies are important because collectively they will:

  • Lay out a financial plan to address your agency’s pension/OPEB liabilities;

  • Provide guidance in making budget decisions and how to use excess or one-time monies;

  • Demonstrate prudent financial management and improve the agency’s credit rating ; and

  • Illustrate to employees and the public the agency’s commitment and plan for responsibly addressing its pension/OPEB liabilities.

Policies should be tailored to reflect each agency’s financial circumstances and policy objectives. Elements of Pension/OPEB Funding Policies

The Basics – In adopting a strong set of pension and OPEB funding policies, we recommend public agencies consider incorporating the following basic elements:

  • Description of the agency’s financial objectives

  • Full description of the agency’s plans and liabilities

  • Financial metrics/targets such as:

  • UAL target levels; and

  • Target levels for reserves

  • Methodology for allocation of additional resources (ADPs)

In addition to these basic elements, we also recommend an agency’s pension/OPEB funding policies include the following provisions:

  • Funding Solutions – Potential funding solutions the agency may consider or implement (e.g., Fresh Start, Tax-Exempt Exchange, Leverage Refunding, Fund Allocation, Use of Reserves, POB’s, etc.)

  • Use of Excess Monies – Guidelines for how excess monies (from budget surpluses, one-time revenues, and unspent capital projects) should be applied toward unfunded liabilities. For example, the policies might stipulate that 50% of such monies be applied toward unfunded pension liabilities, upon the City Manager’s direction

  • Integration with Reserve Policies – Guidelines for the use of reserves and excess monies towards pension/OPEB liabilities

  • 115 Trust – If your agency has or is contemplating a 115 Trust, the policies should describe how and when the 115 Trust monies will be utilized (i.e., as a pension/budget stabilization tool or pre-funding mechanism) and general investment objectives for the 115 Trust

  • POBs and Debt Management Policies – If your agency is contemplating POBs, this option should be consistent with your formal debt management policies and incorporate the following structuring guidelines:

    • Minimum NPV or Cash Flow Savings;

    • UAL Funding Target (i.e., should not exceed 95% funding level);

    • Prohibitions: no current or normal costs or extending payment terms; and

    • Structuring parameters: final term, interest rate/coupon, call provisions

It’s all in the Process….

Pension and OPEB issues involve a myriad of complexities and require a steep learning curve. Drafting good policies provides a vital opportunity for your management team to educate its elected leadership about the driving factors of pension/OPEB liabilities and to have in-depth, detailed discussions about the agency’s financial goals.

Your policies will document a plan or roadmap that you have developed to meet your financial objectives. The “process” of drafting and adopting the policies is just as critical as their adoption – by simply adopting another City’s policies you will forego this critical step and consensus building opportunity.

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